What To Know About the Supreme Court's Sales Tax Decision

SMITH BRAIN TRUST – In a rare move this week, the U.S. Supreme Court overturned its own ruling, with a 5-4 decision that allows states to collect sales tax from out-of-state retailers who sell to their in-state residents. It’s an issue that goes back decades, but one that has evolved with the rise of e-commerce.

In 1992, in the Quill v. North Dakota case, the Supreme Court set a precedent that out-of-state retailers could not be required to collect sales or use tax for sales in states where they don’t have a physical presence. It was before e-commerce, at a time when the comparatively smaller catalog business was more often the way shoppers ordered goods to be delivered to their home.

Under the 1992 decision, retailers without a physical presence in a state could sell products free of sales tax. “Truth be told,” says Samuel Handwerger, lecturer of Accounting and Information Assurance at the University of Maryland’s Robert H. Smith School of Business, “the consumer was supposed to voluntarily pay the sales tax, which was officially called a ‘use’ tax, to the state, but few, if any, did.”

And maybe it didn’t seem like such a big issue to states in those days. Catalog sales existed, but the volume of sales and their potential contribution to a state's tax rolls were negligible, compared to what they are in today’s big and expanding world of e-commerce sales.

“The Quill 1992 case came about right before the exponential growth of online internet sales,” Handwerger says.

The issue came back to light more recently after another Dakota – South Dakota – passed legislation requiring online retailers to collect the sales/use tax for transactions involving customers in that state, regardless of whether the seller maintained a physical presence there. Boston-based online home furnishing retailer Wayfair, along with Overstock and Newegg, immediately challenged the law, citing that favorable Quill decision.

Ultimately, Wayfair lost.

“Today’s change only immediately affects this South Dakota law,” Handwerger says, “but it opens the door for other states to pass similar legislation.”

And that can be a lucrative source of tax income for states, he adds. In 2016, Americans spent an estimated $360.3 billion buying goods online. And by 2020, that figure is expected to top $603.4 billion.

The Supreme Court’s decision this week cites at least two issues that influenced the reason for overturning Quill, Handwerger explains. 

First, it cited “states prosperity,” a reference to the amount of sales taxes not collected by states on these out-of-state sales. “States have argued that this number could be $30 billion or higher,” Handwerger says. “Of late, however, the General Accounting Office said that the real amount is probably in the range of $8 to $13 billion. Nevertheless, the Supreme Court felt that states do not have to be left unable to collect these taxes.” 

Second, the Court said the decision should “even the playing field,” taking away the competitive price disadvantage that in-state stores faced compared to online retailers that don’t charge sales tax. “This advantage is not legally correct since consumers are supposed to pay the tax on their own,” Handwerger notes. “But the burden of enforcement for states is cost prohibitive and the better choice is to require collection from the seller.” 

What happens next?

Congress may now be faced with whether to pass legislation on this issue, Handwerger says, addressing how states should regulate themselves in the collection process. 

For several years, Congress has contemplated but not passed so-called “marketplace fairness” legislation that would have addressed the interstate taxing issues. The proposals would have granted states the right to require retailers outside of their borders to collect tax, but subject to certain restrictions.

“The Supreme Court held off for years prior challenges to Quill thinking – and hoping – that Congress would settle the matter through legislation,” Handwerger says. “Now the tables are turned and we’ll be waiting to see what transpires next.”

For online consumers who exclusively shop the giants of retail – Amazon, Walmart, Target and so on – the decision won’t change anything. Such retailers already have a physical presence in most states and therefore are already collecting sales tax.